To the annoyance of some shareholders, Shanghai Hugong Electric Group Co.,Ltd. (SHSE:603131) shares are down a considerable 27% in the last month, which continues a horrid run for the company. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 14% in that time.

In spite of the heavy fall in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.3x, you may still consider Shanghai Hugong Electric GroupLtd as a stock probably not worth researching with its 3.4x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Shanghai Hugong Electric GroupLtd's Recent Performance Look Like?

For example, consider that Shanghai Hugong Electric GroupLtd's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Shanghai Hugong Electric GroupLtd?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Shanghai Hugong Electric GroupLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 18% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 2.6% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 27% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Shanghai Hugong Electric GroupLtd's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

What We Can Learn From Shanghai Hugong Electric GroupLtd's P/S?

Shanghai Hugong Electric GroupLtd's P/S remain high even after its stock plunged. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Shanghai Hugong Electric GroupLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

You need to take note of risks, for example - Shanghai Hugong Electric GroupLtd has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.